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Several decades of laboratory experiments on human subjects (often students) have revealed that individuals suffer from psychological biases which affect decision making. One particular bias that proved to be persistent across subject groups is miscalibration. Miscalibration is defined as excessive confidence about having accurate information (Alpert and Raiffa 1982, Lichtenstein et al. 1982, Ronis and Yates 1987, Kyle and Wang 1997, Moore and Healy 2008). Miscalibrated people overestimate the precision of their own forecasts or underestimate the variance of risky processes; in other words, their subjective probability distributions are too narrow.
There always exists a tension between psychological findings from the lab and their impact in the real world, especially in corporations and markets. The reason is that corporations and markets systematically penalise bad decisions through price, compensation, and governance mechanisms. Therefore, it is an open question whether psychological biases, such as miscalibration, transcend to top-echelon managers, or whether their biases in beliefs and decision making are mitigated by disciplining mechanisms.
Managers form beliefs and make predictions all the time. They are required to assess future outcomes all the time, whether these relate to sales, returns on investment, or the responses of consumers to a new product.

International financial spillovers from emerging markets have increased significantly over the last 20 years. This column argues that growing financial integration of emerging economies is more important than their rising share in global trade in driving this trend, that firms with lower liquidity and higher borrowing are more subject to spillovers, and that mutual funds are amplifying spillover effects. Policymakers in developed economies should pay increased attention to future spillovers from emerging markets, particularly from China.

Financial spillovers occur when fluctuations in the price of an asset trigger changes in the prices of other assets. They can reflect both desirable effects (incorporation of news into prices) and less desirable ones (transmission of excess volatility due to financial frictions). Recently, financial market volatility in emerging markets seems to have been widely transmitted to asset prices in other countries, even when there is not a crisis or near-crisis. For example, the suspension of trading after the drop of the Chinese stock market on 6 January 2016 affected major asset markets all over the world. The IMF’s Global Financial Stability Report systematically examines the evolution and extent of financial market spillovers from emerging markets, and the underlying drivers of their growth (IMF 2016).

Helicopter money is not monetary policy. It is a fiscal policy carried out with the cooperation of the central bank. That is, if the Fed were to drop $100 bills out of helicopters, it would be doing the Treasury’s bidding.
We are wary of joining the cacophony of commentators on helicopter money, but our sense is that the discussion could use a bit of structure. So, as textbook authors, we aim to provide some pedagogy. (For examples of previous writing, see Bernanke 2016, Baldwin 2016 and Buiter 2014).
To understand why helicopter money is not just another version of unconventional monetary policy, we need to describe both a bit of economic theory and some relevant operational practice. We use simple balance sheets of the central bank and the government to explain.
Friedman’s thought experiment
First, some background. In an essay published in 1969, Milton Friedman described what he believed to be a surefire mechanism that central banks could use to generate inflation (were that desired): drop currency straight from helicopters on to the population, while promising never to remove it from circulation. The result would be higher prices (and, if you keep doing this, inflation).

Oil prices have decreased by about 65% since their recent peak in June 2014 (Figure 1). This dramatic and largely unexpected (Baumeister and Kilian 2016) collapse in prices has sparked intense debate over the causes and consequences. Arguably, the dynamic adjustment has changed the oil market structurally, leaving it quite different from the past. In addition, the manner in which falling oil prices affect the global economy has changed in important ways.
A broader energy perspective is therefore now needed to comprehend oil’s long-term outlook. To this end, this column briefly answers seven questions about the oil market in the global economy.
Figure 1 Crude oil price (APSP)

Question 1: Is the slump attributable to a ‘supply glut’ or to ‘peak demand’?
The evidence suggests that supply factors are better at explaining the initial collapse in oil prices in 2014 than demand factors. A host of issues are involved, including the rapid increase in shale production in the US; a change in strategy in Saudi Arabia, the largest member of Organization of the Petroleum Exporting Countries (OPEC); higher-than-expected output in locals such as Libya and Iraq despite ongoing conflicts; the return of Iranian oil to international markets; and the US’s removal of the oil export ban (Arezki and Blanchard 2014). These factors have persisted.

A growing share of children live apart from one of their parents before reaching adulthood. Many policymakers are concerned about the welfare of these children who (partly) grow up in single-parent households. Numerous papers in various social science disciplines document a strong negative empirical association between parental divorce and a wide range of children’s outcomes. This general relationship is highly persistent, leaving the children of divorced parents economically and emotionally worse off, even in adulthood. Most scholars are aware that it is not clear to what degree this relationship is causal (see, e.g., Manski et al 1992, Painter and Levine 2000, Amato 2010, Bhrolcháin 2013, Gähler and Palmtag 2015). A number of confounding factors that provoke parental divorce – for example, emotional stress or parenting disputes – may also be detrimental to children’s outcomes.
In a new paper, we analyse various outcomes for children who experienced parental divorce (Frimmel et al. 2016). To answer the question of whether children are causally affected by parental divorce, exogenous variation in the divorce likelihood is required. The construction of a valid empirical counterfactual is not only necessary for empirical identification, but also essential for identifying the causal channels through which children are affected.

The two oil production revolutions and what they mean for the price of oil, politics, the economy, and the environment

Roberto F. Aguilera, Marian Radetzki
17 August 2016

After decades of oil price rises, new extraction techniques for shale and conventional deposits mean that recent dramatic price falls will be here to stay. This column argues that, even with oil at $50 a barrel, global producers will invest to catch up with US-led technological innovation and so add 40 million barrels a day to production by 2035. This will revolutionise domestic energy policymaking, environmental commitments and global geopolitics.

Oil price developments over the past 40 years have been truly spectacular. In constant money, prices rose by almost 900% between 1970-72 and 2011-13 (UNCTAD 2015, UNSTAT 2015). Compare this to other exhaustible commodities, and we find that a metal and minerals price index rose by only 68% in real terms in the same period.
In our view, political rather than economic forces have shaped the inadequate growth of upstream oil production capacity, which is the dominant factor behind the long-run upward price push.

Wage inequality was partly behind the vote for Brexit. This column shows how areas with relatively low median wages were substantially more likely to vote ‘Leave’, and discusses the likely implications of Brexit for wage inequality in the future. Increased likelihood of a recession, a negative shock to trade, reduced migration flows, and the possible loss of passporting rights for the City will all alter the structure of wages in ways that will need to carefully monitored and studied in due course.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
The ‘Leave’ outcome of the UK’s referendum on EU membership was in part shaped by issues surrounding today’s labour market inequality, and the actual exit will have implications for inequality in the future. In this chapter we discuss both of these, first showing some evidence that the spatial distribution of Leave votes was correlated with low and stagnating real wage levels, and second considering some key areas of relevance of the vote outcome for aspects of wage inequality.
Wage inequality and voting patterns
Figure 1 shows the first of these, plotting the percentage voting Leave in the referendum against the median weekly wage in local authorities in England, Scotland and Wales.

More bombs, more shells, more napalm: Nation building through foreign intervention
Interventions in weakly institutionalised societies have been central to US foreign policy during the past half-century. Military strategies used during foreign interventions have ranged from the deployment of overwhelming firepower to bottom-up initiatives to win hearts and minds through development aid and civic engagement. Discussions about the form that such interventions should take – if they are pursued at all – remain central to US public discourse, most recently in the context of debates about how to best counter Islamic State.
A central goal in US interventions has been to create a state monopoly on violence that will persist after US withdrawal. Achieving this goal requires both a capable state and citizen compliance. “If it is relatively easy to disperse insurgent forces by purely military action… it is impossible to prevent the return… unless the population cooperates”, writes the military scholar David Galula (1964). Top-down approaches to foreign intervention emphasise gaining citizen compliance by making it costly for citizens to oppose the state, whereas bottom-up approaches aim to increase the benefits of supporting the state by providing public goods, economic aid, and political opportunities.

The UK’s Brexit referendum is providing us with the first significant test of our sparkling new regulatory system. Everyone knew about the referendum months in advance, giving them plenty of time to prepare. Yet, we are left with some fundamental questions related to global financial stability. Do banks have sufficient capital and liquidity to withstand the ‘shock’? Will financial markets continue to serve their key functions? Or, is the financial system only as strong as its weakest link? Will turmoil once again prompt liability holders to run, triggering asset fire sales and compelling central banks once again to do whatever it takes to keep avert a meltdown?
As the rating agencies might say, we are on ‘stress watch’ with a negative outlook.
Troubling signs
Market fluctuations in the immediate aftermath of the referendum were characterised by large currency swings and significant equity price declines, particularly in bank stocks. Aside from the banks, stock markets generally recovered. But, other troubling signs have emerged. In Britain, several open-ended property funds have suspended redemptions (Lazarus et al. 2016). It is doubtful that they could sell illiquid real estate holdings on short notice – except, perhaps, at fire sale prices. And in continental Europe, the strains are building on several large, systemic banks.
Let’s start with the UK property shock.

Since the financial crisis, there has been an active debate about whether and how monetary policy frameworks should incorporate risks to financial stability. The debate has moved beyond the pre-crisis focus on the ability of policymakers to identify asset bubbles and whether monetary policy can stop asset prices from continuing to rise. Research has advanced on adding financial intermediary frictions into monetary policy models. Woodford (2010, 2012) proposes incorporating a credit spread as a third variable in an optimal monetary policy rule with flexible inflation targeting. Christiano et al. (2010) show that stock market booms tend to be accompanied by low inflation, suggesting that policy rules that focus narrowly on inflation targets will destabilise asset markets and the broader economy. Interest rate rules should thus allow an independent role for credit growth to reduce the volatility of output and asset prices.
In a recent paper, we review the growing research on the transmission channels of monetary policy through both financial conditions and financial vulnerabilities (Adrian and Liang 2016). Financial conditions refer to borrowing costs determined by the policy rate, including risk premia for risky assets above the risk-free term structure.

During the Great Recession of 2008-09, a number of countries around the world deployed fiscal stimulus to support activity. As a result, government debt and deficits increased in many countries, and they remain elevated (Huidrom et al. 2016a). Against this backdrop of weak fiscal positions, there has been a revival of interest in fiscal policy as a macroeconomic stabilisation tool (Blanchard and Leigh 2013, Mohlmann and Suyker 2015).
Yet, there is scant evidence regarding the extent to which fiscal policy is effective in stimulating the economy – i.e. the size of fiscal multipliers – over different phases of the business cycle, when implemented against the backdrop of weak initial fiscal positions. In this column, we analyse the relationship between fiscal multipliers and fiscal positions of governments by addressing three questions. First, we ask whether fiscal multipliers depend on the strength of the fiscal position. Second, we analyse whether this state-dependency on the fiscal position is distinct from cyclical effects. Finally, we examine the channels through which the fiscal position affects multipliers.
Dependence of fiscal multipliers on fiscal position
Fiscal multipliers tend to be larger when the fiscal position is stronger.

During the Great Recession of 2008-09, a number of countries around the world deployed fiscal stimulus to support activity. As a result, government debt and deficits increased in many countries, and they remain elevated (Huidrom et al. 2016a). Against this backdrop of weak fiscal positions, there has been a revival of interest in fiscal policy as a macroeconomic stabilisation tool (Blanchard and Leigh 2013, Mohlmann and Suyker 2015).
Yet, there is scant evidence regarding the extent to which fiscal policy is effective in stimulating the economy – i.e. the size of fiscal multipliers – over different phases of the business cycle, when implemented against the backdrop of weak initial fiscal positions. In this column, we analyse the relationship between fiscal multipliers and fiscal positions of governments by addressing three questions. First, we ask whether fiscal multipliers depend on the strength of the fiscal position. Second, we analyse whether this state-dependency on the fiscal position is distinct from cyclical effects. Finally, we examine the channels through which the fiscal position affects multipliers.
Dependence of fiscal multipliers on fiscal position
Fiscal multipliers tend to be larger when the fiscal position is stronger.

Citizens of the UK voted to leave the EU, but voters in Scotland and Northern Ireland expressed a strong wish to remain. Taking a trade perspective, this chapter argues that resolving border issues will be central to finding a Brexit outcome that preserves the UK in its present form. Continued membership of the EEA – with Scotland either a part of the same country or a fellow, independent member – would be the best outcome for the UK.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
Full disclosure: I am a Scottish, international economist with a career-long interest in preferential trading agreements (PTAs). As the Brexit vote has thrown up a PTA conundrum of unprecedented complexity for both the UK and Scotland, I feel duty bound to weigh in on what should come next.
The result of the referendum seems to have little to do with the economic benefits or otherwise of EU membership. They seem to have been driven more by issues of sovereignty and a negative reaction to the Westminster ‘establishment’. Nonetheless, the implications of the UK’s trading relationships post-Brexit are important.

The long and deep recession after the financial and foreign debt crisis has left a legacy of non-performing loans on Italian banks’ balance sheets. In December of 2015, bad loans summed to about €200 billion, a large figure that represents approximately 11.0% of the total amount of loans given (18% including other troubled loans not written off).1 Unlike other recent banking problems, where losses were concentrated in real estate or sovereign debt exposure, close to 80% of these bad debts came from bank lending to non-financial businesses (Bank of Italy 2016a). Credit quality has recently seemed to be improving, and much of the existing stock of impaired loans is backed by collateral.2 However, as we discuss below, recovery times for collateral are long, so the quality of loans continues to be a problem to be taken seriously.
Healthy banks as a policy objective
Policymakers in Italy, from the government to the Italian central bank, understand well the importance of correcting their banks’ problems, as do economists. Much research has established the importance of a healthy banking system in providing the lubricant to grease the wheels of the economy.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here. Listen to Patrick Honohan discuss Ireland and Brexit in the Vox Talk interview here.
Ireland is the remaining EU country most exposed to Brexit. When Britain decided to join the EEC in 1973, it was a foregone conclusion that Ireland would follow. But Ireland’s ancient continental links were relevant, and those links were consolidated over the following half century to the point where Brexit has scarcely awoken any interest for Ireland to consider following suit.
Instead, the concern in Ireland is about the consequences of a future in which the legal basis for the UK’s economic relations with the EU – and hence with Ireland – is thrown into doubt.
Economic links between Ireland and the UK have declined over the past decades, but this should not be exaggerated.
On the eve of the WWII almost 94% of Irish exports went to the UK (and still almost 75% 50 years ago);
Today, the UK’s share of Irish exports is less than 15%.
In considering these figures, however, account needs to be taken of the high import content of much of Ireland’s other trade. That is, the local content of Ireland’s exports to the UK is relatively high. If fully weighted by employment content, the UK share would be closer to a quarter.

How can the Irish economy respond to being torn by between two neighbours by Brexit? Bob Denham (Econ Films) interviews Patrick Honohan (Trinity College Dublin) on what economic connections do and don’t need to be unpicked, from labour markets to managing the border.

Following the referendum decision for the UK to leave the EU, policymakers in both the UK and the EU face will face some difficult choices. These choices are likely to have non-trivial and long-lasting consequences, and macroeconomists can offer guidance on their macroeconomic aspects. This raises questions not only about what macroeconomists can do to obtain a good understanding of the needs of the countries involved, but also about the way that the macroeconomics profession as a whole can effectively make its position known to policymakers and the public.
Before the referendum, there was near unanimity in the profession on the negative economic consequences of a vote for Brexit.1 There are obviously many aspects that matter besides economic arguments, and the outcomes of elections and referenda are typically not easy to understand. But some have argued that neither the economic arguments nor the sureness of economists’ views reached voters and policymakers.
Paul Johnson, director of the Institute for Fiscal Studies (IFS), argues that the profession itself is responsible for these failings.

The effects of benchmarks on international capital flows: The problems of passive investing
In a context where investors hold increasingly globalised portfolios, the issue of which countries (and which securities) belong to relevant international benchmark indices has generated significant attention in the financial world (Financial Times 2015). The reason is that how countries are grouped has implications for the allocation of capital across borders.
As institutional investors become more passive, they follow benchmark indices more closely. These indices change over time. One reason is that index providers reclassify countries, adding or removing them from certain groups. For instance, when they upgrade a country from frontier to emerging market, the investment funds that target these countries and follow their corresponding indices have to change their portfolios accordingly. These changes can result in large capital reallocations given the $37 trillion invested in worldwide open-end funds (ICI 2016) and that most funds follow a few well-known stock and bond market indices. The resulting reallocations can produce unexpected effects in international capital flows, explained by how financial markets work and not necessarily by economic fundamentals.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
If the UK’s vote to leave the European Union was a vote against anything, it was a vote against free movement of workers within the EU – a vote to “take (back) control” over immigration policy. For most economists, this is paradoxical. There is a clear consensus that in the UK the economic impacts of immigration, particularly from within the EU, have been largely benign (Portes 2015). In particular, there is little or no evidence of economically significant negative impacts on native workers, either in terms of jobs or wages, while the public finances and hence public services have, if anything, benefited (Wadsworth et al. 2016).
Watch Jonathan Portes discuss Brexit and UK immigration policy in the video below.
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Nevertheless, immigration was a major factor – perhaps the major factor – in the Brexit vote. Looking at voting behaviour at a local level, while areas with relatively high numbers of immigrants overall were actually more likely to vote to Remain, areas which have seen particularly rapid recent growth in immigrant numbers were more likely to vote to Leave (Carozzi 2016).

Official estimates of income and consumption inequality rank Egypt as one of the world’s most equal countries. The estimates are derived from national household surveys that collect detailed income or consumption data for a sample of households, assumed to be representative of the country’s population.
To obtain estimates of the Gini coefficient for 135 countries around 2008-09 (the most recent period for which we have survey data for Egypt), we consulted the World Bank PovcalNet, a repository of household income and consumption surveys from around the world, to calculate the Gini coefficients in Figure 1. The Gini coefficient is arguably the most commonly used measure of inequality; it ranges between 0 and 1 with higher values indicating more inequality. In this case the most unequal countries are on the left, becoming progressively more equal as we move to the right. Egypt’s Gini is just over 0.3, which is low by international standards. It is even low by the standards of the region, as the highlighted countries show.
Figure 1 Gini coefficient for 135 countries from around the world

Note: Countries sorted by Gini index (from highest to lowest inequality). Surveys are within two years of 2008.Source: Authors’ calculations based on PovcalNet and All the Ginis (Milanovic, 2014).
This will come as a surprise to many Egyptians.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
In 2003, when assessing whether the UK should join the European single currency, one of Gordon Brown’s five economic tests was: “What impact would entry into European monetary union have on the competitive position of the UK’s financial services industry, particularly the City’s wholesale markets?”1 The financial sector was the only industry singled out for specific consideration when considering making a major step toward greater European integration.
The reason that the financial industry got such attention is that the City of London, the name given generally to the UK’s financial markets and the industry that goes with them, is an important part of the UK economy and a leading global financial centre:2
The sector generates a substantial share of UK economic activity.
Although only accounting for 3.4% of UK workforce jobs, financial and insurance services account for 8% of UK gross value added (2013 figures taken from ONS 2015).
The sector generates a large trade surplus.
Financial services together with insurance and pension services ran a £58 billion trade surplus in 2014 (+3.2% of GDP). This helped to offset the trade deficits run by other sectors such that the overall trade deficit was £34.

Immigration is among the hottest and most divisive topics in politics today. US presidential hopefuls Hilary Clinton and Donald Trump embody the discord surrounding these issues – Trump’s rhetoric states that immigrants replace and hurt American workers, while Clinton is often quick to point out that immigrants are essential to starting businesses that put Americans to work. Moreover, many local and regional governments seek to attract immigrant entrepreneurs to their areas through programmes like the Thrive competition in New York City and the Office of New Americans in Chicago. While economists have made headway towards measuring the immigrant contribution to entrepreneurship and economic growth, these data are only now getting to the point where facts can begin to replace speculation in these debates.
Previous work regarding immigrant entrepreneurship has shown that rates of business ownership are higher amongst the foreign-born than natives in many developed countries, including the US, the UK, Canada, and Australia.1 Hunt (2011) finds that skilled immigrants start firms with greater frequency than comparable natives, and that those initially arriving on a study or work visa were more likely to start a firm than those arriving for family reunification.

Financial market infrastructures (FMIs) are the backbone of the financial system. Although steps have been taken to make it less likely, if an FMI were to fail it could have catastrophic consequences for financial markets and the economy at large. This column introduces four recommendations from the CEPS Resolution Taskforce for policymakers in case of such an event, based on coordination, timeliness, and remedying the impediments to FMI resolvability.

Financial market infrastructures (FMIs) are the backbone of the financial system. They enable market participants to transact with one another in an efficient manner. FMIs are inherently systemic, as their very names imply – payments systems, securities settlement systems (SSSs), and central counterparties (CCPs). If an FMI were to cease operations, it could put a stop to payments and/or securities and derivatives transactions. That in turn could destabilise financial markets and possibly the economy at large.
In effect, FMIs are ‘single points of failure’. They reduce risk as long as they remain robust, but they concentrate risk, and serve as a conduit for contagion if they do fail. Moreover, the risks posed by FMIs are highly correlated.

The Brexit vote has created particular uncertainty for London, the EU’s largest financial centre. This column looks at the issues facing the UK’s banking sector in the wake of the referendum: the right to conduct cross-border activity in the EU in future, the impact on flexible recruitment in London, the possibility of diverging UK and EU regulation, and the effect on bank profitability more widely across Europe.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here. You can listen to Patricia Jackson discuss the potential impact of Brexit on the UK financial section in a Vox Talk interview here.
The Brexit vote has undoubtedly created uncertainty and market volatility, with particular uncertainty for London, the EU’s largest financial centre. One issue facing the UK banking sector is the right to conduct cross-border activity in the EU (so-called ‘passporting’) when the UK is no longer an EU member. Another is the impact of Brexit on flexible recruitment in London. A further issue is the possibility that UK regulation moves away from that in the EU. The final question is the effect on bank profitability more widely across Europe.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
Watch Jim Rollo discuss the impact of Brexit on the UK’s regulations in the video below.
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For over four decades, the EU has managed most international trade policy on behalf of the UK. Brexit changes all this. The UK now needs to debate and define its ambitions for international trade and then negotiate them with its partners.
In leaving the EU, it will reassert its status as an individual member of the WTO and will need to determine all the details of its trade policy within the framework of WTO rules. However, WTO rules offer considerably less market access than do the Single Market in the EU or the FTAs that the EU has negotiated with other partners to their markets.
Moreover, extracting the UK from the EU’s commitments in the WTO entails complications and negotiation. This column warns that the ‘WTO option’ for UK trade is not a simple or attractive way to continue UK trade – i.e. that maintaining exports requires that we do better than that. It also argues that the key to being able to do better is to cultivate cooperation and goodwill with the remaining members of the EU (the EU27) and our other WTO partners. It is a diplomatic challenge.

Would losing passporting really be a crisis for the City? Or could the finance sector find a way around newly-imposed restrictions? Bob Denham (Econ Films) asks Patricia Jackson (Atom, Ernst & Young) about the attractiveness of London, the likelihood of a mass exodus and the future of British finance.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
Watch Nicholas Crafts discuss the historical context of Brexit in the video below
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The voters have opted for Brexit. It seems that the UK will soon leave the EU, having been a member since 1973. This is despite warnings from many economists that such a decision would probably entail very significant economic costs, not only in the short run during the transition period but also in the long run through a permanently lower level of income and productivity (Table 1). On the other side, claims are made that, freed from the constraints imposed by EU membership, economic policy reforms can deliver a faster rate of economic growth so that, at least in the long run, the UK economy will benefit from Brexit.
Table 1 Long-run impact of Brexit on level of real GDP (%)
LSE
-7.9
HM Treasury
-3.8 to -7.5
NIESR
-7.8
Source: adapted from Ebell and Warren (2016).
It has been widely noted that after the UK joined the EU its relative growth performance compared with France and Germany showed a sustained improvement (Table 2).

In theory, a poor country with a low saving rate but good growth prospects can build up its capital stock by running a large and sustained current account deficit. This column asks whether this is feasible and productive in practice. A substantial number of countries in recent decades have been able to run large current account deficits for as long as ten years, but such episodes typically do not end happily. Foreign finance does not appear to be the cure for countries with low domestic savings.

In a closed economy, investment is limited by domestic savings. In an open economy, in contrast, countries can invest more than they save by tapping foreign finance. In theory, a poor country with a low saving rate but good growth prospects can build up its capital stock by running a large and sustained current account deficit. The question is whether this is feasible and productive in practice.
In a new paper, we address this question by first identifying large and persistent current account deficits episodes and then exploring the implications of these episodes for long-run growth and economic stability (Cavallo et al. 2016).
The IMF has long regarded current account deficits greater than 4% of GDP as a danger sign.

Editors’ note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.
Brexit means Brexit. Consequently, the UK must now formulate and execute an independent trade policy for the first time in over 40 years. The purpose of this column is to summarise the catalogue of failure that has been the governance of the world trading system in the 21st century, done with an eye to extracting lessons for future UK trade policy.
For sure, there have been a few bright spots but, in its essentials, the governance of world trade has not taken a major step forward since the accession of China to the WTO in late 2001. Regional trade deals have yet to provide a template to update the current set of global trade rules that were agreed back in 1994, over 20 years ago.
While trade negotiators talk and talk, the world has moved on. Business has not stood still – some continue to expand supply chains (Baldwin 2012), while others are localising production to overcome new protectionist barriers (Bhatia et al. 2016). Many governments have acted unilaterally too, revisiting their commitment to a level playing field in the wake of the Global Crisis (Aggarwal and Evenett 2014).

Most macroeconomists are familiar with an accounting framework whereby changes in the government debt-to-GDP ratio are split into the contributions of the primary fiscal surplus and the interest-growth rate differential times the debt ratio. This framework is useful for thinking about how past increases or decreases in debt ratios occurred, and to draw possible lessons for the future path of debt ratios (e.g. Reinhart and Sbrancia 2015, Abbas et al. 2014). This issue is important in many advanced economies, where debt ratios rose from an average of 72% at end the end of 2007 to 106% by the end of 2015, largely as a result of the global economic and financial crisis. It is especially relevant in the Eurozone, where the combination of low growth and unsustainable debt persists in Greece, and memories of the interest-debt spiral experienced by Spain and Italy in 2011 and 2012 are still fresh.
The traditional accounting, however, under-emphasises the role of economic growth. When considering the factors underlying changes in the debt ratio, most authors will mention that the primary surplus itself is affected by economic growth, but stop short of quantifying the importance of that additional channel. As a consequence, the impact of growth on debt ratios is not wholly internalised in policy deliberations or analytical discussions.